Bonds & Interest Rates

Fed’s Rocket Ship Turns Hoverboard

Posted by Peter Schiff - Euro Pacific Capital

on Wednesday, 9 December 2015 0:02

imagesRelated: Peter Schiff Warns: “The whole Economy Has Imploded….Collapse Is Coming” 12/07/2015

Fed’s Rocket Ship Turns Hoverboard

Over the past year, while the U.S. economy has continually missed expectations, Federal Reserve Chairwoman Janet Yellen has assured all who could stay awake during her press conferences that it was strong enough to withstand tighter monetary policy. In delivering months of mildly tough talk (with nothing in the way of action), Yellen began stressing that WHEN the Fed would finally raise rates (for the first time in almost a decade) was not nearly as important as how fast and how high  the increases would be once they started. Not only did this blunt the criticism of those who felt that the delays were unnecessary, and in fact dangerous, but it also began laying the groundwork for the Fed to do nothing over a much longer time period. To the delight of investors, the Fed has telegraphed that it will adopt a “low and slow” trajectory for the foreseeable future and move, in the words of Larry Kudlow, like “an injured snail.”

I would suggest that Kudlow is a bit aggressive. I believe that if the Fed raises rates by 25 basis points next week, as everyone expects it will, that the move will likely represent the END of the tightening cycle, not the beginning. (As I explained in my last commentary, the current tightening cycle actually started more than two years ago when the Fed began shortening its forward guidance on Quantitative Easing). The expected rate hike this month has long been referred to as “liftoff” for the Fed, an image that suggests the very beginning of a process that eventually puts a spacecraft into orbit. But, in this case, liftoff will be far less dramatic. I believe the Fed’s rocket to nowhere will hover above the launch pad for a considerable period of time before ultimately falling back down to Earth.
 
If we believe that the Fed will remain “data dependent”, then we should not even expect an increase this month. The latest batch of data, including terrible retail sales figures, an ISM manufacturing number that indicates we may already be in a manufacturing recession, and a much weaker than expected ISM service sector number, show an economy that is rapidly decelerating. Even last week’s supposedly good jobs report, that showed 211,000 jobs created in November, included a huge jump in the number of people (319,000) taking part-time jobs because they couldn’t find full-time work.(Bureau of Labor Statistics, 12/7/15)
                                                                                                                                                    
This current “recovery,” engineered by the largest monetary experiment in history, that has left us with trillions of dollars of new debt that we will likely never be able to repay, is quickly running out of what little steam it had. On average, since the Second World War, the U.S. economy has experienced a recession every six years. Since it is approaching eight years since our last official recession began, time is not on our side. Interestingly, the Wall Street Journal reported this week on its front page that the “junk” bond market is poised to notch its first annual loss since the 2008-2009 financial crisis. Many economists consider distress in these high yield debt instruments as an early sign of a recession.   
 
But rather than admit its rosy forecasts were too optimistic, and risk losing much of its remaining credibility, the Fed is apparently prepared to prove to the markets that it has the ability to deliver tough love with an actual rate hike. But that’s the easy part. Although I believe that even 25 basis points may be too much of a headwind for this anemic economy to overcome, it’s not something that should really spread fear in a marginally healthy economy. The dollar did not rally by 30% or more over the past year against many currencies based on the fear of a 25 basis point rate hike. What really moved markets and currencies was the prospect of a bona fide tightening cycle. 
 
These fears moved into sharp focus in September when widespread fears of an imminent rate hike had caused the Dow to experience its first 10% correction in four years. That is when Yellen began stressing that it’s not the first rate hike that is important, but what happens after. As a result, Wall Street now sees liftoff as a far less significant event, with far more attention being paid to the ultimate flight path.
 
As late as this summer many economists were predicting that Fed funds would be at least 2% by the end of 2017. The Fed’s own forecasters still see rates at more than 2.5% by early 2018, according to its Summary of Economic Projections released 9/17/15. But over the last few months, those predictions have flattened out more than an open can of soda in the sun. The current Fed Funds futures contracts imply a 79% chance that the Fed raises rates in December (Reuters, 12/4/15). That figure is about as high as it has been for quite a few months. But the market also indicates that rates may only rise twice more by the end of 2016. (Reuters 12/4/15) This would put Fed Funds at 75 basis points by next December, presuming a 25 basis rise this month. That pace is less than half of the last rate tightening cycle of 2004-2006, when the Fed raised rates by 25 basis points for 17 consecutive meetings (Federal Reserve Bank of NY). (It’s interesting to recall that then Fed Chairman Alan Greenspan was criticized for moving too slowly at that time, and even more so in the aftermath of the bursting of the housing bubble, as many correctly concluded that the Fed’s measured pace had allowed the bubble to grow unnecessarily).
 
I believe that when it comes to gold, commodities and currencies, we may be headed into a “buy the rumor, sell the fact” market that might turn the tables on the trends of the past four years. In this case, the “rumor” was a meaningful tightening cycle that would restore positive real rates, but the “fact” is likely to be a symbolic 25 basis point nudge. This “one and done/wait and see” scenario is gaining a surprising amount of support, especially among those Wall Street investment firms whose livelihood depends on perennially positive markets. How else could you explain the 4% rally in gold that had occurred from the lows on Thursday to the highs on Friday last week if not for the fact that markets are coming to expect much more tender loving care from the Fed?
 
I believe that the Fed understands the deteriorating economic data better than it cares to admit. But candor is rarely high on a Fed Chairperson’s agenda. (In an interview this week on the Freakonomics Podcast, former Fed Chairman Ben Bernanke blundered by accidentally telling the truth regarding his penchant for painting unjustifiably rosy economic pictures while in office, saying, “I was representing the administration. And you don’t really want to go out and say, ‘Run for the hills,’ right?” In other words, one should expect the same partisan cheerleading from the supposedly independent Fed chairman as one gets from the blatantly partisan White House Press Secretary). This time around the Fed’s rhetoric has now backed it into a corner, where its credibility with the markets is at stake. If they fail to deliver 25 basis points in December, as they have failed to do many times this year, then the markets may be shocked by the Fed’s lack of confidence.  As a result, they may reluctantly deliver a rate hike, even though the data they supposedly depend on would argue against it. But if all we get is a symbolic 25 basis point increase, then, I believe, any economic confidence that the Fed hoped would be implied by its actions will be lost anyway.
 
The real problem for the Fed will be how foolish it will look if it does raise by 25 basis points and is then forced by a slowing economy to lower rates back to zero soon after liftoff. At that point, the markets should finally understand that the Fed is powerless to get out of the stimulus trap it has created. But it looks like the Fed would rather look foolish later when it’s forced to cut rates, than look foolish now by not raising them at all.
 
Given that we are going into an election year, look for the Fed to be hyper-vigilant in keeping the economy, and the financial markets,  from contracting through the spring and summer. History has shown that the incumbent presidential party fares very poorly in an election year when the economy is bad. Just ask George H.W. Bush, whose post-Gulf War popularity evaporated in the face of the 1992 recession, which turned out to be one of the mildest in memory. Can anyone really expect that the Fed’s left-leaning leadership will sit still while a recession gains momentum and, in so doing, run the risk of easing Donald Trump into the White House?  
 

In her testimony before Congress last week, Yellen indicated that if the economy unexpectedly slipped back into recession in 2016, and it turned out that the Fed had raised rates, it would simply reverse course and lower them. She also stated she would launch another round of Quantitative Easing (QE), because the program “worked so well in the past.” But a recession that begins so soon after a 25 basis point rate increase, or even with rates still at zero, should prove to even the Fed’s biggest boosters that its stimuli were complete and utter failures. But in government, nothing succeeds like failure.

 
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On Thursday, Janet Yellen testified before the Joint Economic Committee. What can we learn from her testimony?

Fed Chairwoman Janet Yellen is going to raise interest rates in December. She basically reiterated her view on the economy and the future of the Fed policy on Wednesday at the Economic Club of Washington and said that the U.S. had recovered substantially since the Great Recession, and the labor market had tightened. Inflation continues to run low, but Yellen expects it to move up to the FOMC’s 2 percent objective over the next few years. Here was the key paragraph:

“That initial rate increase would reflect the Committee’s judgment, based on a range of indicators, that the economy would continue to grow at a pace sufficient to generate further labor market improvement and a return of inflation to 2 percent, even after the reduction in policy accommodation. As I have already noted, I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market. Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane.”

Interestingly, she justified a need for a rise citing the lags in the effects of monetary policy and explicitly admitting that the Fed could create excessive risk-taking:

“However, we must also take into account the well-documented lags in the effects of monetary policy. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.”

Yes, after nearly seven years of zero interest rates, massive asset price inflation all over the world and financial bubbles in emerging markets, the Fed is now concerned about excessive risk-taking. Well, better late than never.

The question-and-answer session indicated that Yellen is quite decided to raise interest rates in December as she decisively downplayed all the reasons to hold rates unchanged cited by the U.S. lawmakers. Other Fed officials also seem to be determined to hike this month. For example, St. Louis Fed President James Bullard said the U.S. central bank should start moving the benchmark lending rate and balance sheet “toward more normal levels.” The new Philadelphia Federal Reserve president Patrick Harker would also prefer hiking sooner rather than later.

The take-home message is that the Fed officials seem to be determined to hike in December. The small raise this month is a foregone conclusion, which should be factored in the gold price. Now, the crucial question for the gold market is the pace of the whole tightening cycle and how the Fed is going to normalize its monetary policy given the huge excess reserves held by commercial banks.

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Institutions Dump Stocks For Fifth Consecutive Week; Record Selling Capitulation Hits Industrials

Posted by ZeroHedge

on Tuesday, 8 December 2015 15:30

Over the past month (and year) the market may appear rangebound driven mostly by a handful of top stocks, but below the surface the “smart money” continues to sell.

According to Bank of America last week, during which the S&P 500 was essentially flat, BofAML clients were net sellers of $1.3bn of US stocks, following two weeks of net buying. Net sales were led by institutional clients, who have sold US stocks for the last five consecutive weeks. Hedge funds were also net sellers following two weeks of buying, while private clients were the sole net buyers. Private clients have bought US stocks in four of the last five weeks, and net buying by this group last week was the biggest in two months (chiefly due to ETFs).

2015 cumulative institutionals

Extreme Leverage in a Gold Futures Market Nearing the Breaking Point

Posted by Clint Siegner

on Tuesday, 8 December 2015 15:19

The metals markets rallied strongly on Friday – action which came as a surprise to many. The gains snapped a 6-week losing streak for gold, silver, and platinum. Prices rose despite a stronger-than-expected November jobs report raising the odds the Fed will hike interest rates later this month.

Perhaps silver and gold futures finally caught a safe-haven bid on news of the terrorism-linked shooting in Southern California.

Or perhaps it was a relief rally based on metals being heavily oversold and investors realizing that a quarter percent Fed rate hike may already be “priced-in.” Especially given that Janet Yellen stood out front last week and downplayed the significance of raising rates. She wants investors to expect lower average rates than we’ve seen historically and to know a decision to hike in December does NOT necessarily mean more rate hikes will follow.

3654654Or maybe, at last, the gold shorts are getting nervous about the extraordinary leverage in the futures markets. Coverage continues to decline. Recent reports show 325 paper ounces in open interest for each ounce of registered physical stock. This is certainly cause for alarm as we head into the December delivery window for the COMEX.

Bullion Banks Positioned for Higher Prices

We recently covered the extraordinary leverage in the COMEX, particularly in gold futures. The coverage ratio was 293 paper ounces in open interest for each single ounce of registered physical metal in COMEX vaults. Over the past couple of weeks, that leverage has grown further to around 325 to 1 – more than triple the already extreme levels of just a few months ago. It is certainly a trend to watch carefully in the coming weeks and months.

However, skyrocketing leverage in the COMEX isn’t the only extreme for metals investors to pay attention to. The positioning – long versus short – of swap dealers (who are largely represented by the bullion banks) relative to managed money (largely comprised of hedge funds and other speculators) is also in uncharted territory. And it may be good news for the bulls.

 Managed money has been building toward a net short position in recent weeks, providing much of the push for lower spot prices. In the most recent CFTC Commitment of Traders report, dated Dec. 1st, this crowd was positioned a record 55.1% short. Six weeks ago, this number was only 17.3%. Meanwhile the bullion banks (swap dealers) have been going long – a record 64.2% long to be exact.

What does this mean? Well, if history is a guide, it means the bullion banks are about to take the speculative shorts out to the woodshed.

Data shows that when managed money and the swap dealers build extreme positions in opposing directions, a change in price trend is likely coming. And the swap dealers – banks – rarely, if ever, lose.

The bullion banks have an exceptional track record when it comes to trading metals. Many consider their success to be the result of outright manipulation and control of the markets, rather than clever trading. This notion is supported by a slew of recent settlements and guilty pleas for rigging markets. The bullion banks are no ally to bullion investors, but precious metals bulls can take heart in the fact that banks are lined up on their side, for the moment.

There is no certainty prices are set to move higher from here, of course. The metals markets have been even more unpredictable than usual in recent months and the data in the Commitment of Traders report is a few days old before it is even published. But there is plenty for metals investors to keep an eye on in December and some good reasons to believe prices will rise.

 

Clint Siegner is a Director at Money Metals Exchange, the national precious metals company named 2015 “Dealer of the Year” in the United States by an independent global ratings group. A graduate of Linfield College in Oregon, Siegner puts his experience in business management along with his passion for personal liberty, limited government, and honest money into the development of Money Metals’ brand and reach. This includes writing extensively on the bullion markets and their intersection with policy and world affairs.

 

Year-End Inflection Points: Dead Ahead

Posted by Eric Coffin

on Tuesday, 8 December 2015 15:00

From the December 2, 2015 HRA Journal: Issue 243

Over to you, Draghi and Yellen.

This month, like many other months recently it’s the intentions of central bankers that are dominating the markets.   It’s widely expected that the ECB and US Fed will drift even further apart in their basic policy stances this month.   I’m pretty sure that view will turn out to be correct though as always the devil will be in the details. 

Increasing certainty about upcoming policy moves has traders increasingly certain about how different markets will move and they are placing bets accordingly.   Traders in New York are expecting Santa to deliver new all-time highs.   He may grant that wish on momentum alone but if we get many more sub-par economic readings the jolly old elf may decide to break out the coal lumps to stuff stockings with.

Traders are behaving with even more certainty, alas, in the gold market.  It’s been all short gold and long dollar since the middle of October. There has been no respite yet.  I continue to believe we may in fact get some if the Fed raises rates as expected.  The key word here is “expected”. This has to be the most anticipated, front run and telegraphed interest rate change in history.   It’s hard to believe that anyone interested in trading the outcome hasn’t placed their bets already.   That being the case there is still potential for a sell (dollars) buy (gold) on news trade the market is not expecting. 

***

A lot of things are going to happen in the next two or three weeks that could set the stage for the entire 2016 market and determine if 2015 is a winning or losing year for the big board.

The combination of decision makers at the ECB and US Fed this month loom largest for near term market direction for both equities and currencies.  The monthly payroll report and the latest decision by OPEC on cutting (or not) oil production will also impact.  Some of this will be coming at you immediately after you read this editorial.  The Fed meeting, arguably the most important data point is furthest away but only two weeks out.

We’ll start with an updated US Dollar chart since its value is a distillation of trader’s beliefs about central bank intentions and relative strength of different economic blocks, the US and Europe in particular.

As you can see from the chart below the USD continues to strengthen, though less than the dollar bulls expected so far.  The index has been unable to break through the spring high.  I find this interesting as the Euro has weakened and conviction about a Fed rate increase continues to grow.  I’ve noted before how one-sided the dollar trade is and, if anything, it’s even more crowded now.

dec7-1

You can see the impact of the surging dollar in the gold chart below.  Gold is hitting new lows and trading

around the upper range of the target I had for longer term bottom.  Charts for many other metals and other commodities look similar.  For gold to make that bottom the USD has to stall out and preferably reverse and start heading lower.

Virtually everyone expects the Dollar to continue powering higher as the Fed starts raising rates.  I’m in a very small minority (a minority of one as far as I can tell) that believes a rate increase may mark at least an interim top in the dollar.

Why?  Several reasons.  The first and simplest is how one sided the trade is.  Currency traders trade charts.  Chart patterns are the reason for the 120 target and I agree that target looks “logical”.  That said, the main reason longs keep piling on is the upcoming Fed decision.  Once that decision is announced traders will have to decide whether to “sell on news” and take profits.  I expect many to do just that.

dec7-2

The Fed made a mistake not raising rates almost two years ago. They know it.  They also know that there is virtually no inflation in sight and they are starting a tightening round very late in the economic cycle.

I do think rates get raised this month but I think the FOMC will go to extraordinary lengths to convince the market the pace of increases will be VERY slow.  For all the outward bullishness the markets are shaky and growth is slow.  The Fed can’t afford to spook traders now. If the Fed succeeds in soft peddling this increase the odds of currency traders locking in profits increases.

A second factor that could cap the dollar is the ECB.  Its meeting comes first.  Like everyone else I expect Mario Draghi to be dovish, the question is how dovish.  He has reason to be lax.  Deflation continues to stalk the Eurozone and bond yields are getting increasingly negative.  The rate differential has decimated the Euro and Draghi is totally fine with that.  The cheaper currency has been a boon for exports.  PMI, employment and production levels have all been better than expected.

Draghi has every reason to cut rates and expand QE as he hinted he would do. The market expects it and is pricing it in.  Now he has to live up to expectations.  He might meet or beat them but remember that there are ECB board members that are inflation hawks and hate the idea of QE.  There will be pressure to temper Draghi’s enthusiasm even though he’s been right and QE is definitely helping economy. 

I don’t pretend to be privy to the internal decision making of the ECB board.  Maybe the markets are right but there is a realistic chance the ECB does less than expected given how high those expectations are.  If that happens the Euro gets a boost and the dollar a haircut.

The third and perhaps most important reason is also one I have touched on before.  The strong dollar is doing a lot of damage to corporate profits and the wider economy.  The chart below comes from a presentation given by none other than Stanley Fischer, vice-chair of the Fed.  He’s an inflation hawk and has been pretty consistent in his calls for higher rates.

dec7-3

The presentation centered on the impact of a rising dollar on the US economy.  The chart shows the negative impact of a 10% appreciation in the USD over time.  Note that this chart is tracking the negative impact on GDP—the percentage decrease in growth over three years after a 10% move in the currency.  

The impact is not small. A 10% currency move can cut GDP growth by 1.5%.  The move in the USD so far has been about 15% and plenty of currency traders expect another 15% plus going forward.  That implies a decrease in GDP growth of up to 3% from an economy that wasn’t booming to begin with.  Perhaps this explains why the US economy has been decelerating this year and not hitting the “liftoff” Wall St keeps expecting?

We’ve seen plenty of ongoing impacts lately.  Exports, manufacturing PMIs and spending numbers have all come in below consensus. You can see how those low readings are impacting the latest estimates for this quarter’s growth.  Like in Q3 the current GDPNow estimate is far below Wall St consensus.  The latest reading is a meagre 1.4%.  Keep in mind that this reading has been more accurate than Wall St consensus lately.

dec7-4

So far this quarter consumer spending has been a big disappointment.  We just passed the Black Friday kick off to the holiday spending season.  Sales were way below estimates.  I don’t think any of this will dissuade the Fed.  If they blink again at this month’s meeting their credibility will be destroyed.  At the end of the day that credibility is the main source of the “moral suasion” a central bank exerts. The Fed can’t afford to lose that even if raising rates is dangerous.

Weak sales are leading to high inventory buildup and this is one of the first danger signs of a potential recession.  The chart below shows how much the inventory to sales ratio has expanding since mid-2014.  Unless consumer spending accelerates soon we’ll start seeing businesses cutting production to try and get this ratio back in line. 

The big board indices are a couple of percent from their highs.  The “Santa Claus” rally is one of the most dependable and it may finally allow new highs to be reached.  Do not underestimate the dangers though. 

Many market internals have continued to weaken and the economy has continued to slowly decelerate. Broader and equal weighted indices continue to struggle.  It’s still a small number of companies carrying the entire rally. The potential for a major top in the markets is as high as it was three or four months ago.  Optimism could still prevail but the next month or so will be tricky.  

The bottom line is I agree with the consensus in terms of what will happen in the next two weeks but disagree on the impact it will have.  I think there is a good chance the dollar tops when the Fed lifts rates and the potential for a policy mistake overwhelming the market is high. 

That backdrop could mark a final bottom for gold prices.  It won’t do base metals or other commodities as much good.  A falling dollar will help but in the absence of much better and broadly believed readings from China it will take mine closures to convince traders base metals are bottoming. 

dec7-5

Gold is in the danger zone. The central bank meetings could generate a spike lower, though we’re running out of sellers.  The positioning in the futures market is as bearish as it has ever been.  That’s scary but also a classic contrarian signal.  When the market is this bearish it’s due for a bounce.  Whether that is a bounce of the dead cat variety or the start of something more important will depend on the USD.  If I’m right about it topping out soon we should be set up for a rally in gold and gold stocks.  Stay vigilant. We could see some resolution to this endless bear run very soon. 

Ω

 

 

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